Why Zoltan Pozsar’s ‘Bretton Woods III’ Won’t Work

A fairy tale.

That’s what I called Zoltan Pozsar’s Bretton Woods III framework earlier this month.

My critique, which actually spanned a pair of articles, isn’t amenable to summary treatment, much as Pozsar’s notes often elude attempts at abridgment. In many cases, paraphrasing Pozsar is impossible.

Read more:

Zoltan Pozsar’s Fairy Tale

Zoltan Pozsar Declares Dawn Of ‘New World Monetary Order’

Pressed to describe my take, as expounded across those two linked pieces, I’d simply say that, in my view, Pozsar’s Bretton Woods III framework won’t work.

As it turns out, Rabobank’s Michael Every agrees, and he explained why in a 16-page marathon called, aptly, “Why ‘Bretton Woods III’ Won’t Work.” I should note, right away, that Every doesn’t mention Pozsar by name.

Unlike myself, and very much unlike Zoltan, Every is willing and able to summarize his views in readily accessible prose. In fact, he delivered an incisive assessment of Bretton Woods III in just one sentence: “Nice narrative, but it’s just mercantilism.”

To be sure, Every agrees with much of what Pozsar wrote. Some of the “core arguments,” as he called them, are sound, but “sound” may be a misnomer in this context. I called Zoltan’s last exposition “more jumble than genius.” Pozsar seems unwilling to view the world through any lens that’s not his own. He developed the most holistic known framework for mapping and analyzing global funding markets, which (arguably) makes him one of the world’s foremost authorities on banking. Because money makes the world go round, he’s able to see things other people can’t see, sometimes before they happen. People like, for example, Jamie Dimon, might feel or intuit them (Jeremy Irons in Margin Call style), but Pozsar has the (literal) blueprint. His (reportedly ready) access to traders lets him pinpoint where, in the building, problems might develop.

But the world isn’t just money markets. In that sense, “holistic” isn’t the right adjective for Pozsar’s work. At some point, the analogies become stretched. Even Perry Mehrling’s and Pozsar’s “Bagehot was a Shadow Banker” feels somewhat forced, although developments over the past nine years admittedly flatter the full title, which made a grandiose claim for the authors, who modestly suggested they’d write “the future of global finance” in just 17 pages (minus the bibliography).

In his Bretton Woods III exposition, Pozsar rediscovered old continents (figuratively and, in some sense, literally) and seemingly mistook them for a new world. He’s a reverse Christopher Columbus. He put on his infallible lenses and saw the old world without realizing it.

Of course, the market’s fascination with Pozsar’s “new world order” has more to do with his name, humanity’s perverse fascination with calamity and the public’s generalized gullibility, than it does with the merits of the thesis. I could’ve chosen from an entire universe of titles for this article that would’ve conveyed the nature of the discussion, but how many readers outside of my core cult following would’ve clicked on it if I hadn’t used “Pozsar” and “Bretton Woods III”? Not as many, that’s for sure.

Rabo’s Every made a similar point, albeit in less caustic terms and without naming names. “Markets like a good narrative,” he wrote, adding that,

Bretton Woods III has one given: High inflation and commodity prices; central bank impotence; concerns over the imminent withdraw of US QE — and fears over what having to restart it would imply; and talk of geopolitical and geoeconomic realignments and fracturing. Moreover, Bretton Woods III does not require the audience to suspend much disbelief. Relative US political, economic, financial and military muscle has declined in recent decades.

Note the reference to “the audience.” When Bloomberg or, more commonly, so-called “alternative” finance portals, revel in stories like the one Pozsar pitched, you’re not an investor. You’re a consumer — someone who paid the price of admission via a subscriber fee or your ad-monetized clicks, to watch a movie. You bought a ticket and you’re in the audience, as Every put it. (Note: This article isn’t behind my paywall and I disabled most of the ads, because “principles” and such.)

But depending on which theater your choose (which sites you peruse), it’s not quite the same movie. In some theaters, the film is based on a slightly different screenplay, albeit all adapted from the same original note. In a few cases, the real price of admission is hidden. Sure, the price of the ticket was just a click, and thereby a few pennies for the theater from the ads they showed you prior to the opening credits. But the true cost is your sanity or even your allegiance to Western democracy, both of which are eroded if you choose the theater screening the propagandized version, as too many market participants do.

As it happens, Rabo’s Every used a film analogy to the make the point about waning American hegemony. “Even US soft power is fading: China’s movie box office has been larger than the US since 2018, dominated by local films,” he wrote. “The famous ‘Sunset Boulevard’ line from a fading movie star is, ‘I am big. It’s the pictures that got small.’ The US is still big, but others are no longer as relatively small as they were.”

But, as he went on to illustrate by way of the flow chart (below), Bretton Woods III isn’t new. In fact, Every observed, “it takes us almost full circle in time and FX structure.”

Once again, Pozsar is a kind of reverse Columbus. He sailed west, missed the new world entirely (in this case because it wasn’t there), landed back east and called it “new.”

Every proceeded to remind the world that commodities-based currency foundations are cumbersome, unwieldy, incompatible with prevailing fiscal trends and conducive to violence.

Inflation, he wrote, was “only well contained on average by regular deflation” during the 1800s. The emphasis is important. A gold standard is conducive to more, not less, macro volatility. When you handcuff yourself to a finite metal, the government and the banking sector are constrained in their capacity to expand and extend credit. That can be ruinous. Reverting to such a system is a total non-starter in modernity. Choosing that path would guarantee the return of episodic depressions (with a “d”) in developed economies, and new gold discoveries (assuming there are any left) would lead to unpredictable bouts of inflation.

Relatedly, Every wrote that governments are now almost universally in favor of more fiscal expenditures in the name of national security and social welfare. “The gold standard didn’t stop the many attempted revolutions of 1848 or 1870 in Europe,” he noted. “Rather it encouraged them [and] one could expect the same under Bretton Woods III.”

Have a look at the figure (below). The quip in the chart header alludes to the sheer, blatant absurdity inherent in suggesting China can constrain itself via a commodities-linked FX system.

“On the private side, China has seen an explosion of debt since 2008,” Every said, warning that were Beijing to tie “itself to an FX commodity standard, [it] would mean implosive deflation in Chinese asset prices if new lending was capped.” He continued, noting that China’s total public sector debt, including local governments, “is already that of a European state.” On the IMF’s estimates, China’s augmented deficit was almost 17% of GDP in 2021.

From a geopolitical perspective, a gold standard is, by definition, zero sum. Unless you discover new gold, there are only two ways of obtaining it for state coffers: Through trade or through war. What Pozsar doesn’t mention is that exogenous money is, historically, conducive to conflict.

Every made an absolutely crucial point that I alluded to above. “When debt-based expansions end, similar problems can arise, as we see today,” he said. “Yet embracing a global commodity currency standard would guarantee that outcome from the outset.”

That can’t be emphasized enough. All of the problems we see today — larger booms/busts, the return of macro volatility, scarcity and the threat of armed conflict between major powers — may be the end game of long-cycle expansions in fiat-/credit-based systems, but they’re a fixture of commodity-linked systems.

Next, Every reiterated why the dollar remains the best candidate for a global reserve currency. The first point should be self-evident, but judging by some market participants’ fascination with the purported “new world order,” it isn’t. You can’t trust commodity currencies precisely because they’re commodity currencies — the link to commodities is a liability, not an asset.

Last week, Goldman’s Jeff Currie said copper “is likely to be the tightest commodity we’ve ever seen.” As Bloomberg’s Joe Weisenthal (Tracy Alloway’s co-host on the “Odd Lots” podcast, which sometimes doubles as a PR platform for Pozsar) wrote Thursday, “not only is copper going to be incredibly tight, it’s absolutely essential if we’re going to electrify everything and move more energy use off of oil.” That would appear to argue for the Chilean peso as the world’s reserve currency. Who’s in favor? Show of hands.

There are, of course, commodity currencies which are more reliable. Do you know why? Because they’re pegged to the dollar. What would the riyal look like in the 21st century without the dollar peg (or absent an SDR link)? I don’t know. Neither do you. Neither does Pozsar. Neither does Mohammed Bin Salman. And with the possible exception of Zoltan, I don’t think any of us want to find out.

I’ve been very vocal about the idea that the weaponization of the dollar and the US financial system undermines the greenback’s appeal as a reserve currency. I was talking (and writing) about that long before my current incarnation. It’s also been a key talking point on this site for years. However, I’ve mercilessly lampooned the notion that CNY is less politicized. As I put it time and again, if you think the US Treasury is capricious, just wait until the fate of your accumulated national wealth rests with the Politburo. And remember: Once you get into CNY in size, it’s not so easy to get out.

Every reiterated those points. “Yes, USD (EUR, JPY, etc.) are now ‘weaponized’ for Afghanistan, Russia, Belarus and anyone who supports the invasion of Ukraine, but CNY is highly politicized, as is RUB, and Chinese markets have seen net capital outflows since the start of the Ukraine war,” he wrote, before asking, “Do any potential Bretton Woods III currencies inspire broad global trust, or just in pockets?” I can answer that, and so can you.

As for inflation, here’s what’s likely to happen over the medium-term: The Fed will (accidentally or intentionally) hike the US economy into recession. As that unfolds, real rates in the US will rise, both as a result of higher policy rates and as a mechanical byproduct of falling breakevens. That should be a boon to the dollar, and the greenback will likely become more negatively correlated to commodity prices, which will be falling anyway as the knock-on effects of a US recession manifest in slower global growth. In that scenario, we’ll all forget about Bretton Woods III within 12 months.

Moving along, Pozsar’s contention that a eurorenminbi system can rival the eurodollar system is laughable. I’ve hesitated to put it that way in previous articles because arguing with Pozsar about the eurodollar system is about like arguing evolution with Darwin (or intelligent design with God, if you’re on that side of the “debate”), but there it is. It’s farcical. Every was more generous, but no less emphatic. To wit:

No other global currencies offer the scale of US markets or its ‘network effect.’ Try to talk about trends in global GDP without using USD as the common denominator. In a reflexive logic, the more people who use a currency, the more the currency is used. This is particularly the case in terms of Eurodollars. The sheer scale — hence power — of Eurodollar debt means setting up an alternative is a daunting task: Even China had $2.7 trillion of FX debt as of the end of Q42021. Indeed, if one presumes USD will be pushed aside, one is logically arguing a lot of Eurodollar debt will default, as few will be able to earn enough USD to repay it. That would mean global market chaos.

That’s the “method of accounting” case for the dollar. I assume the “means of exchange” case needn’t be extolled: If you absolutely have to buy something from someone who’s ready, willing and anxious to sell it, the dollar is accepted by everyone, everywhere, from Walmart checkout lines to Bangkok bars to Sinaloa safe houses.

And please, spare me the crypto protestations. I’ve been there and done that now. Here’s how you buy an expensive NFT: You put US dollars into an account, you transfer those US dollars to a centralized crypto exchange or directly to a crypto hot wallet, you then convert those dollars to Ethereum, then you buy the NFT. It starts with dollars and, assuming you want to use any profits to pay taxes or transact in places that don’t accept crypto, in ends in dollars too.

Finally, note that, as Every wrote, “any Bretton Woods III currency trying to push USD aside would have to be willing to run large trade deficits, [but] if commodity prices are high, major commodity producers run trade surpluses, stopping the spread of their currency and if commodity prices collapse, their currency does too, again limiting its global attractiveness.”

Even if you could get past all of that, Bretton Woods III is fundamentally flawed from the outset. Commodities are crucial (humans need to eat and keep warm/cool), but they don’t constitute the lion’s share of global goods trade (figure below, from the same Rabo report).

You might argue that without commodities, a lot of what we consume can’t be manufactured in the first place, but as Every went on to note, most major global food and mineral exporters aren’t on board with this, for a laundry list of reasons, some of which are obvious: Nobody besides Moscow (and maybe Tehran) is excited about the prospect of CNY hegemony.

One thing Pozsar doesn’t sufficiently address is the fact that you can’t run the global oil market on the yuan without major currency reform. It literally won’t work. Every has written on this extensively, and he drove the point home with a line he’s used before: “Global oil markets need a base currency that’s liquid (which CNY isn’t), freely tradable (which CNY isn’t) and stable (which CNY only is because it doesn’t meet the other two criteria, and because it’s soft-pegged to the USD).”

That’s a succinct critique. And you can apply it to trade in other key commodities too. Sure, things are in flux right now, but once the dust (or radioactive ash) settles, most participants in global trade and finance won’t want to invoice in an illiquid, not-freely-tradable currency, especially when you consider that overhauling the existing system in favor of a new system that uses a base currency which references (via the trading band) the old base currency, is ludicrously redundant.

From there, Every worked through a dizzying array of possible currency and trade permutations in an effort to find a viable avenue for a CNY-commodities-Bretton Woods III regime. Over five pages, thousands of words, more than a dozen charts and voluminous data, he demonstrated that currently, the math just doesn’t work. If numbers don’t lie, Bretton Woods III, as envisioned in popular discourse anyway, isn’t possible in the near-term and probably not in the medium-term either.

Ultimately, Every’s critique is devastating to Bretton Woods III, and I have to believe that was purposeful. I’d reiterate (one more time) that he doesn’t mention Pozsar by name, but just as funding markets are Pozsar’s wheelhouse, this is Every’s.

I’ll be the first to admit that his dailies can be maddening, and I don’t always agree with them. When it comes to telling both sides of a given story, Every is committed, to put it mildly. If it’s confirmation bias you’re after, the only way you’re going to get it from Every is by happenstance — you can’t rely on him to parrot your worldview or anyone else’s other than his own. One day he’s pointing out the sheer absurdity in the Kremlin’s contention that stationing 100,000 troops on Ukraine’s borders doesn’t presage an invasion, and the next he’s calling out one-sided coverage of domestic American political flashpoints by US mainstream media outlets. So, some days you’ll find yourself wholly enamored with his missives, and other days you’ll be shaking your head, slightly irritated, but usually better informed. If he has biases (and everyone does), I’ve yet to discern them. Nobody is immune in an Every note. Pozsar included.

With that, I’ll leave you with one final, poignant passage from Every’s Bretton Woods III critique:

Moreover, the West can walk away — as it is pledging to do from Russian energy. Unless every commodity producer backs Bretton Woods III, there are alternatives — and/or technological innovation to reduce commodity intensity. And, to reiterate, if all key commodity producers walked away from the West, they would lose those markets for their commodities. The only way Bretton Woods III could avoid this problem would be if the global economy fragments into multiple value chains. The West still has key resources, technology, allies, a strong military and could even onshore production if needed. Could Bretton Woods III commodity producers (and China as importer) replicate or sustain value chains without Western technology and Western end consumers? Looking back, some Bretton Woods III countries tried that during the last Cold War, and import substitution didn’t work well for them. Moreover, look at the terrible demography in Russia and China, and their structural economic problems. Could either afford to walk away into a more isolated, combative realpolitik Bretton Woods III?

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